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Thursday, June 2, 2016

Capitalism and Inequality: What Does the Future Hold?

Thomas Piketty produced an enormously influential
historical study of wealth during the capitalist era in Capital in the Twenty-First Century. His work produced the
conclusion that the return on investment in capital has historically been at
the level of about 5%. It dipped below
that value during the period in the twentieth century marked by two world wars,
the Great Depression and the post World War II recovery period. Since that period, return on capital has
returned to about the historical level.
Piketty’s study also concluded that the historical growth in income (on
a per capita basis) was much lower except during that anomalous twentieth
century period. The high growth observed
in the postwar years has since returned to the lower historical mean.

The obvious conclusion to be drawn from Piketty’s view is
that capital (equivalent to wealth in Piketty’s reckoning) will continue to
grow faster than the income earned from labor leading to ever greater
inequality. The lesson of the postwar
years is that public policy, particularly with respect to taxation, led to
diminished inequality and higher growth.
From Piketty:

“….it is important to note that
the effect of the tax on capital income is not to reduce the total accumulation
of wealth but to modify the structure of the wealth distribution over the long
run. In terms of the theoretical model,
as well as in the historical data, an increase in the tax on capital income
from 0 to 30 percent (reducing the net return on capital from 5 to 3.5 percent)
may well leave the total stock of capital unchanged over the long run for the
simple reason that the decrease in the upper centile’s share of wealth is
compensated by the rise of the middle class.
This is precisely what happened in the twentieth century—although the
lesson is sometimes forgotten today.”

The postwar European policies were much more aggressive
than those in the US and led to greater growth of the middle class. Tax policy was seen as the most effective way
to alter inequality, provided taxes were used to provide services that were of
value to all. The middle class would be
the ones who would benefit the most from the provided services.

“….modern redistribution does
not consist in transferring income from the rich to the poor, at least not in
so explicit a way. It consists rather in
financing public services and replacement incomes that are more or less equal
for everyone, especially in the areas of health, education, and pensions.”

It should be noted that if the middle class benefits most
from services provided by the government in the areas of health education, and
pensions, it is the middle class that will suffer the most if those government
services are scaled back or withdrawn.

Branko Milanovic has also tried his hand at providing
understanding of inequality at the global level and predicting what the future
might hold. He has produced the very
worthy and lucid book Global Inequality: A New Approach for the Age of Globalization. Milanovic
has collected a large amount of fascinating data on income levels around the
world and tracked the evolution over recent decades. This allows him to evaluate the effects
globalization has had on incomes in both wealthy and non-wealthy countries, and
to produce some interesting conclusions.

Milanovic also tries to produce an hypothesis to explain
the dynamics that control economic evolution and predict how income inequality
might change over time. He believes that
Picketty’s theory is inadequate to explain all the data, and suggests that a
variation on and older idea presented by Simon Kuznets is more appropriate. Kuznets
was a very accomplished economist. One
of his deductions from perusal of the data available to him at the time was the
existence of what came to be known as the Kuznets curve. From Wikipedia:

“Among his several discoveries which sparked important theoretical research
programs was the Kuznets curve, an inverted U-shaped relation between income
inequality and economic growth (1955, 1963). In poor countries, economic growth
increased the income disparity between rich and poor people. In wealthier
countries, economic growth narrowed the difference. By noting patterns of
income inequality in developed and underdeveloped countries, he proposed that
as countries experienced economic growth, the income inequality first increases
and then decreases. The reasoning was that in order to experience growth,
countries had to shift from agricultural to industrial sectors. While there was
little variation in the agricultural income, industrialization led to large
differences in income. Additionally, as economies experienced growth, mass
education provided greater opportunities which decreased the inequality and the
lower income portion of the population gained political power to change
governmental policies.”

Both Piketty
and Kuznets would predict growing inequality in the nineteenth century, but
without demonstrating it, Milanovic claims that the data on inequality in the
UK and the US look to him like a Kuznets curve rather than anything Piketty
could produce. He then can claim, again
without much in the way of justification, that, two world wars and the Great
Depression notwithstanding, the postwar fall in inequality was merely following
the economic evolution the Kuznets hypothesis predicted.

Milanovic
grants that Piketty correctly predicts the rise in inequality that occurred after
the postwar period and continues to this day—which Kuznets could not. In order to maintain his faith in the Kuznets
curve he has to postulate that this rise must have been caused by a new
industrial revolution that triggered a rise in inequality similar to that
caused by the transition from an agricultural economy to a mechanized one. Kuznets events can then come in waves. Milanovic proposes that the rise of information
technology has been responsible for this latest increase in inequality. That conclusion is controversial. Paul Krugman does a good job of trashing that
notion in Challenging the Oligarchy.

It was not the intention to produce a detailed resolution
of the differences between the views of Milanovic and Piketty. The issue here relates to the quite different
predictions for the future.

Milanovic’s view suggests that there are economic
mechanisms within the capitalist system itself by which inequality can be
diminished. He predicts that US
inequality will begin to decline, although he describes the US as currently enduring
a “perfect storm of inequality.” He seems to conclude that wars and revolutions
are also “economic mechanisms,” consequently he may eventually be correct.

Piketty’s view suggests that the natural evolution of a
capitalist society is to plutocracy unless inequality is explicitly constrained
by society. A Great Recession did little
to convince our society of the need to rein in capitalism. The only data we have suggests that a Great
Depression and two world wars are necessary to do the trick.

Perhaps it is useful to remind ourselves what mindset
emerged in Europe from the experience of a Great Depression and two world wars. Tony Judt provides us with some insight from
his book Postwar: A History of Europe Since 1945.

“The state, it was widely
believed, would always do a better job than the unrestricted market: not just
in dispensing justice and securing the realm, or distributing goods and
services, but in designing and applying strategies for social cohesion, moral
sustenance and cultural vitality. The
notion that such matters might better be left to enlightened self-interest and
the workings of a free market in commodities and ideas was regarded in mainstream
European political and academic circles as a quaint relic of pre-Keynesian
times: at best a failure to learn the lessons of the Depression, at worst an
invitation to conflict and a veiled appeal to the basest human instincts”

“The state, then, was a good
thing; and there was a lot of it….The overwhelming bulk of the increase in
spending went on insurance, pensions, health, education and housing.”

This attitude towards capitalism and economics generated
an enormous growth in the middle class in Europe. The subsequent rise in influence of
market-based decisions has been gradually eliminating the middle class.

There has to be an optimal middle ground between these
extremes, but how do we get there?

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About Me

Hi, my name is Rich Couch. I spent my first career as a physical scientist. Now that I am retired I have chosen to go in another direction. I have had a lifelong love of books and an urge to write. Since I am not a story teller and I am way too old to start a new career I have found an outlet in writing essays combining reviews and my opinions of books and articles on politics and current affairs. My hope is that others will find what I have produced interesting and informative--and well written.